Much has been made about the recent uptick in home sales. Some pundits are calling a housing bottom and claiming that things will soon return to normal. Others claim that things will get worse. Our opinion is based on the fundamentals of demand and supply and the resulting pricing pressures.
Supply and Demand
The more houses that are available for sale vs. willing buyers, the less each house will sell for. We have record housing overhang. Many astute observers have commented on the shadow inventory that includes homes in default that are not yet on the market. Today’s (November 24, 2009) Wall Street Journal has a front page article stating that 1 in 4 mortgagors are underwater, emanating from homes that were purchased in 2006 or 2007. Clearly, a high and rising mortgage default rate, along with massive amounts of underwater mortgages, means that more supply will be added to the “for sale” inventory in the coming months.
Housing affordability is a function of income and credit availability. If you don’t have income, you can’t afford a house payment. The average American is making the same real income as they were a decade ago, but has significantly higher personal debt. The real costs of insurance, food, tuition and other expenditures have all risen during this same period, leaving most people with less money for discretionary consumption. Meanwhile, the cost of a new home is still high relative to income. Lower incomes with rising fixed costs of living are not a recipe for rising home prices. Continuing job losses are also an ominous sign.
The Impact of Deficits and Taxes
Record Government deficits also mean that taxes will rise in the future (through tax hikes, and through the hidden tax of money printing and inflation). Higher taxes mean that less income is available for businesses to pay out as wages, and less after tax income for workers. It is easy to see that current trends don’t support rising incomes over the near term.
Credit and Interest Costs
Credit availability is also an important factor in housing prices. Few people buy their houses with cash, and thus need to get a loan in order to make a purchase. Mortgage rates are currently very low, due to Government subsidies. Without subsidies, mortgage interest rates will rise and bring down affordability and thus home prices. To see the effects of rising interest rates, Google “mortgage calculator” and play around with a few scenarios. Remember, buying a home at what appears to be a rock bottom price today may actually be a sky-high price if wages continue to stagnate and mortgage rates climb significantly.
Rents and Home Values
Like any other investment, houses have a cap rate, the return on investment one would get if the house were rented. Look at places like Craig’s List to get a feel for average rental prices in a given area. Using an average monthly rental income, one can then return to the mortgage calculator and see what it would cost to finance a house. Rents should cover the mortgage, and allow for property taxes, maintenance, and upkeep. If rents don’t cover the mortgage, the buyer is speculating that the value of the house will rise, maybe not a good idea in the current environment. It is also important to look at the total number of rentals in the area (supply and demand again), as well as trends in rental rates (up or down).
Last, but not least is the mortgage reset chart. There are trillions of dollars in loans that will be coming due or will reprice over the next few years. All of these loans will need to be refinanced in the most likely scenario of higher interest rates (and the resulting lower home values). While we can only speculate on what will happen to each specific loan, and on what interest rates will be when each loan comes due or reprices, we can reasonably infer that most people’s payments will go up, not down.
When Government Support Ends
The Government has thrown over a trillion dollars at the housing market, purchasing mortgage bonds and providing incentives to various groups of homebuyers. It should not come as a surprise that spending such vast sums has temporarily propped-up home sales.
It is important to remember that the fundamentals of markets always apply in the long term. Governments can not add debt forever, as higher debt leads to higher interest rates and inflation, and perhaps, even social unrest. The Government can not prop-up housing forever.
The inferences we make from the above observations are not good news for the economy of for the American homeowner. Nevertheless, based on the facts, it is hard to come to any conclusion other than that home price declines are still ahead.
November 24, 2009
|Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States. A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II. A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.|